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Tuesday, July 20, 2010

DEFLATING DOLLAR

In my last post I briefly explained the mechanics of the gold cycles. Tonight I'm going to do the same thing for the dollar.

Like I did with gold I'll start with the largest cycle, in the dollars case it is the 3 year cycle.

Before I go any further I should probably explain the concept of left and right translated cycles, as it is pertinent to the current situation we find ourselves in.

When I call a cycle left translated what I'm saying, in effect, is that the cycle topped left of center. As an example any dollar 3 year cycle that tops in less than a 18 months would be labeled a left translated cycle. One that tops later than 18 months would be a right translated cycle.

Why do we care whether a cycle is left or right translated you ask? Well because how a cycle tops will tell us more times than not whether we are in a bear trend or bull trend.

Cycles that top as left translated cycles are the hallmark of bear markets and more often than not the cycle trough, when it comes, will move below the prior trough. The opposite is true for right translated cycles.

You can see that from `95 till 2001 the dollar was in a secular bull trend. Each one of those cycles topped as extreme right translated cycles and consequently each three year cycle low bottomed well above the previous three year low.

That changed after 2001. You can see that the three year cycle that began in the fall of 2001 topped very quickly and then spent the better part of three years declining into the `04 three year cycle low which obviously bottomed considerably below the 2001 low. The next three year cycle also unfolded as a left translated cycle and it too moved below the prior major cycle low.

Now despite all the bullish talk about the dollar this cycle is also playing out as an extremely left translated cycle which means the odds are high it too will move below the previous cycle low.

Unless the dollar recovers quickly and exceeds the high at 90 it will be in jeopardy of breaking to new lows by next year.

I've said this for some time now that the market is eventually going to make Bernanke pay a terrible price for his insane monetary policy. In the real world, a world where magic doesn't work, and Santa Claus and the tooth fairy aren't real, it's not possible to print literally trillions of dollars out of thin air and not have something bad happen to your currency.

I'm sorry folks but the world just doesn't work that way. If it did we could just print and print till there wasn't a tree left standing and the value of the dollar would just go up and up.

I dare say any teenager can probably grasp the concept of supply and demand. The dollar isn't immune to the laws of supply and demand any more than any other commodity.

Now if you really believe the Fed can create a strong currency by printing the dollar into oblivion then I have some ocean front property here in Vegas I'd like to sell you :)

The bottom line is that the dollar is approaching the timing band for that move down into the three year cycle low, and unless something changes quick it is in jeopardy of crashing to new lows during that move. And when a currency crashes it is an extremely inflationary event.

Next let's move down to the smaller intermediate cycle.

Like gold this cycle tends to last about 20 weeks most of the time. However when Ben cranks the printing presses up it tends to stretch the cycle. You can see that both intermediate cycles during the period of quantitative easing stretched rather long and the second was also extremely left translated.

Now however we have a right translated cycle and one that is moving into the timing band for an intermediate bottom. Since it is right translated the odds are it should hold above the prior cycle low which came in around 79.50.

Now here is the problem and it has to do with the daily cycle.

The daily cycle on average lasts about 20-30 days. The recent low is just slightly in the timing band for that low. If this turns out to be the cycle low (and we will have to wait a bit before we can make that determination) then the dollar needs to put in an intermediate bottom right here right now also. If the dollar rolls over and another left translated daily cycle begins it will almost surely break through not only the 82 pivot but the long term support level at 80.

If that happens then the odds are going to be high that the decline into the three year cycle low has its hooks into the dollar and we will indeed see the dollar move to new all time lows by next year. If that scenario unfolds it will unleash severe inflationary pressures.

I tend to think the recent divergence by virtually the entire commodity sector is already giving us a warning that the market may be ready to exact it's toll for the Fed meddling.

We've already seen a mini-crisis in the Euro. It's only a matter of time until the cancer spreads to the worlds reserve currency, and our time may be up.

Chart of total debt to GDP. This is about a year old so it's actually a bit higher now. Those who think debt is contracting are sorely mistaken. The government has just taken over where the consumer has left off.

108 comments:

I discovered this blog several months ago, and have been looking to make my first gold purchase on a decent pullback. Thus far, I've just had to twiddle my thumbs, and I was hoping this recent decline would offer up an entry.

If the dollar breaks 80, maybe you're right, but until then I'm just not convinced. Also you keep talking about the Fed printing trillions and trillions of dollars, do you have any evidence of this besides the balance sheet expansion of the Fed in 2008? Inflationists always use go back to the theory that Ben Bernanke is deep in a bunker somewhere printing dollar bills with his buddies but in reality you have no evidence whatsoever that he could be doing that on a daily basis, and frankly it's kind of ludicrous to believe that's what he does for his day job.

The bond market is just not going along with your analysis quite yet either, and until the Euro breaks out of it's downtrend I think it's still quite safe to be long the dollar. Like I said I'll stay long until 90 or 100 and then when the inflationists have thrown in the towel on the current cycle it will finally be time probably for an inflationary cycle.

What we've had since 2009 is a bounce from deeply oversold conditions in almost every asset class. I don't think it's been much else besides that.

Also if the bond market had trended downward since 2002 I would agree that we had a lot of inflation from 2002-2008, but since it didn't I have to think that inflationists got that period wrong. In actuality I think the supply/demand imbalance for commodities was favorable during that period due to the growth in Asia so commodities were in a cyclical bull market. But the bull market ended in a bubble since the housing bubble mania bled over into oil and other commodities as people became crazy speculators once again.

The bond market will show the way and until commodities actually make more higher lows and not exhibit long term double top formations (copper for instance) I'm on the deflationary side.

There is simply no dening this as virtually all commodities and most financial assets have risen sharply since March 09.I think your definition of and take on inflation is very simplistic and borders on conspiracy theorist (BB and his printing machine).I can't take it seriously.I don't understand how you believe we are in the midst of an inflationary spiral when credit has contracted so much and continues to do so at a still alarming rate. The credit contraction might be overwhelming the supply of money for all we know.I think one of the key issues in laymen discussion of de/inflation is that there is a steadfast fascination with consumer prices, which can be symptoms of monetary phenomena.If inflation is just prices going up then fine, but I can't see a real consistent and proportional relationship/correlation between the movement of underlying commodities futures/spot prices and CPI components. So then I wouldn't extrapolate to being on the severe inflation road, let alone hyperinflation.

I couple of technical notes. First, the paper on which the USD is printed is made from cotton, not trees ;-)

Second, I see the last intermediate cycle in the buck as having bottomed four weeks later then you have marked because that later dip was the one that broke the cycle trend line and spawned a more powerful rally.

As such, we are now only on Week 14, giving us up to 2 more months to find the intermediate low. We should see at least one more daily cycle decline before that low, and possibly two.

The other thing is you keep saying there's a treasuries bubble?What bubble? You've told us what to expect when the gold bubble gets going, but your bond "bubble" hardly fits what you think a bubble should look like.Most investors on the street barely know what yield and price of these instruments are, let alone go and tell their neighbor they've parked all their money in Treasuries. Maybe I'm missing something and Joe Average or Moe Ron is leveraged to the hilt in the government bond markets?People still talk about stocks and commodities.From my experience the sentiment indicators you use may help in identifying intermediate cycle peaks and troughs but they have absolutely nothing to do with real sentiment towards things like Treasuries and the Dollar.I think 8 of 10 people I meet believe the Dollar is Worthless story. Every bounce in the Dollar is looked at as relief rally, or short covering rally. 8 out of 10 have no clue what a bond is.All talk and associated irrational fear of possible hyperinflation, IMO, conveniently or willfully ignores the realities of central banking developments since 30's, and since they removed gold from the currency picture.I'm in PMs (bullion and miners) and cash, FWIW>

I still don't get the dollar analysis, since it is relative to other garbage currencies. I get looking at oil, gold, nat gas, etc. But I guess you are presuming that the USD will be the worst of the bunch. Either way I don't see the value in looking at the dollar index, when (with the exception of the CAD; Bank of Canada raised rates again), I think all the other currencies are garbage, and believe you are comparing garbage with garbage. Are you anticipating a dollar collapse relative to the other garbage first that will eventually cause the other currencies to fall relative to the inflationary pressures in commodities? This might make sense. Could you please clarify?

Bonds are in a bubble due to the mathematics. Unless you believe the 5 year can go negative, you are fooling yourself if you believe bonds can go any higher from here. Looking at bonds as a sign of deflation, is like looking at real estate for signs of prosperity. It is a mistake, and one that will be very very costly for those holding long-dated bonds. You are better in cash. Eventually rates will rise, and if Ben and Obama keep stimulus going and keep borrowing at these cheap rates, the problem will only intensify the problem, where the only thing that will happen is a surge in interest rates. Bonds and fixed USD products will get killed. The gov is doing exactly what we did during the real estate bubble; borrowing as much as we can to facilitate a min payment. Hyperinflation is becoming more probable every day, although still not evitable. If the deficit were under control, I may have a different view.

How did bonds outperform stocks during the last decade, yet with all that supposed inflation during that period they should have gotten killed? It's amazing how theories can cloud judgement when all you have to do is look at price action.

Front-running the end of any bull is usually not healthy, even people who shorted housing early lost money. Trend followers wait until markets turn before calling the end to a trend.

I think most people underestimate the borrowing power of the United States.People don't like to compare Japan's money problems to the US's now because the Japanese have a massive savings culture and pool to draw from to support their system. Well people need to understand that the US draws from global savings. That's not going to change any time soon, and not for a few decades, because no matter what problems the US has or decay it is undergoing, its financial system is the only place people feel safe parking their money at. Why? Because at the end of the day you can hire a lawyer and fight for your rights.There is a level of transparency and support from the system for the individual that simply does not exist and will not exist in the rest of the world for decades to come.Where have all of Greece's well off transferred their wealth and savings to? At the slightest sign of trouble in places like Brazil, India, Russia, Thailand, wherever, the people with wealth immediately transfer their cash to the US.People need to get all this in understanding what the US Dollar is. Let's assume the US becomes 100% more investor unfriendly. It will still be where everyone knows their money's safe.Good luck getting Buffett or Gates or Soros transferring the bulk of their cash to a relatively advanced Asian nation like Singapore, the new world private banking hub.So what if yields are low?People's love affair with yield, greed may take them to the poorhouse in a fragile or weak global economy, once China comes crashing down. When everyone around you is losing more than 10% in stocks and commodities and corp bonds, low yielding sovereign debts will look awesome.

Every working person in the world that has a 401K knows what a bond fund is. It's their "conservative" choice on their 401K and the one that they have been running to ever since the market crashed in 08.

Just look at a long term chart of the 30 year bond price. 30 years of upward trending price complete with the typical parabolic move right at the end.

We all know that all non-govt credit is contracting and must contract most severely to fix this problem we are in. Anyone out there getting credit? Very little and very few. The banks know what is coming.

If total credit was expanding at an exponential rate there would be massive speculation going on in the financial markets. But there is no evidence of that whatsoever in the price action of any asset class that I can see. Can you back up your claim with real data? Wouldn't the long bond be collapsing if that was truly the case?

I think most folks are aware that government deficits and debts are huge and growing.

The question is the degree to which this offsets private sector contraction ... the destruction of the "shadow banking system," the contraction of loan books and persistence of loan losses, the unwillingness of banks to do anything with a trillion in excess reserves.

I am not currently a PM bear, but I also think Justin has a fair point. Those trillion-dollar deficits, combined with 10-years at 3%, are not the stuff of inflation, imo. Perhaps it's just around the corner,

so, we still having the inflation/deflation debate. I guess depending on how one measures either of these is the difference. If one looks only at the CPI as published the the US Government, one would conclude there is no inflation. If one looked at the CPI as it was once calculated we get a different result.

"According to the latest report from Shadowstats:

Alternative Consumer Inflation Measures

"Adjusted to pre-Clinton (1990) methodology, annual CPI inflation was roughly 4.3% in June 2010, versus 5.4% in May, while the SGS-Alternate Consumer Inflation Measure, which reverses gimmicked changes to official CPI reporting methodologies back to 1980, was about 8.4% (8.37% for those using the extra digit) in June, versus 9.2% in May.

The SGS-Alternate Consumer Inflation Measure adjusts on an additive basis for the cumulative impact on the annual inflation rate of various methodological changes made by the BLS. Over the decades, the BLS has altered the meaning of the CPI from being a measure of the cost of living needed to maintain a constant standard of living, to something that no longer reflects the constant-standard-of-living concept. Roughly five percentage points of the additive SGS adjustment reflect the BLS’s formal estimate of the impact of methodological changes; roughly two percentage points reflect changes by the BLS, where SGS has estimated the impact not otherwise published by the BLS."

I think gary dealt with the question of credit inflation showing the increase in government credit. Whether this has balanced the decrease in consumer credit I suppose could be debated.

Anyway, I am still in the stagflation (for now)camp as I have been (and said so on this blog back in '07 that we would have stagflation followed by a currency crisis)

A relaxation of the accounting rules affects the triggers for capital adequacy, but it does not by itself prompt an expansion of credit. Whether the banking system is bleeding or not, it has to be willing and able to facilitate the expansion of credit to enable inflation. As it is, they still seem to be in hunker-down mode.

I'm still not seeing the ongoing inflation you're seeing, Gary. Since it seems so obvious to you, one of us is clearly missing something.

Just because I'm an anonymous poster doesn't mean I assume the person missing something is you, BTW. :-)

I'll say it again. In a purely fiat system deflation is a choice not an inevitabilty.

As long as a government is willing to sacrifice it's currency (that is the most important part of the statement) they can easily defeat any deflationary tendencies.

The only thing stopping the government from printing and mailing out checks to everone is the threat of destroying the dollar.

But as long as they are willing to take that risk the government could mail a check for a million dollars to every man, woman, and child. That would force liquidity into the system. All debts would be paid off in debased currency and we would no longer have a deflation problem.

We would however have a severe inflation problem.

The Fed has to balance it's money printing tendencies so as to not destroy the currency to quickly. If they get it wrong we have a currency crisis.

I think Ben probably got it wrong last year and we are going to pay a price.

Mish defines inflation/ deflation by including credit and that's a mistake and why he has a deflationary bias.

Here's how Saville explains the difference:

The other area of disagreement between ourselves and Mish lies in the definition of inflation and deflation. Mish asserts that inflation is an expansion in the total supply of money AND credit, with deflation being the opposite (a contraction in the total supply of money AND credit). Our view, however, is that credit should be excluded from the definition. To be specific, we define inflation as an increase in the total supply of money, with deflation being the opposite condition.

There are many cases in which an increase in the supply of credit will lead to an increase in the supply of money. For example, most bank loans result in the creation of new deposit currency. To be more specific, when a bank makes a loan it doesn't transfer part of its existing deposit base to the borrower; rather, it creates new money "out of thin air" and thus alters the value of all existing currency units. However, not all increases in credit result in the creation of new money. For example, when Bill lends money to his friend Bob there is an increase in the total amount of credit in the economy, but the only thing that has happened in this situation is that purchasing power has been temporarily transferred from Bill to Bob. The Bill-Bob transaction affects neither the supply nor the value of existing currency units and is therefore not inflationary.

Similarly, a decrease in the supply of credit could lead to a decrease in the supply of money, but credit contraction is not, in and of itself, deflationary. For example, when a bank suffers loan losses the immediate result is a contraction of credit, but not a reduction in the supply of money. This is because the money that was created when the loans were made still exists after the loans fail. In this situation, however, the bank's ability to make FUTURE loans may be impaired by the loan losses, meaning that there could be less money-supply growth in the future.

Loan losses are, in effect, investment losses, and investment losses are not deflationary per se. Investment losses can LEAD to deflation by impairing the economy-wide ability to lend/borrow new money into existence, but we shouldn't assume that large investment losses within the banking system -- and the resultant credit contraction -- will NECESSARILY lead to deflation. The main reason we shouldn't make this assumption is that the government will ALWAYS be able to borrow and the central bank will ALWAYS be able to lend. For example, if it chose to do so the US Federal Government could borrow 10 trillion new dollars into existence tomorrow by simply issuing $10 trillion of bonds to the Fed.

Credit contraction is DEFLATIONARY. Massive growth in credit is what sows the seeds for massive deflation. So we've sown the seeds, now we reap what we sow.

Like I said before Ben will only do something crazy when he panics, and he won't before that because he won't have the political will. But ultimately the bond market will tell us ahead of time whether we should really be concerned about it or not, along with the commodity markets and the value of the dollar. Currently they are saying don't be concerned.

The same arguments happened before the oil crash and the real estate bubble. Bonds are easy to see as in a bubble, and when it explodes, a currency crisis will most likely begin. Maybe that will be enough to convince everyone that inflation is alive and well...no not that things cost more, but some dumb data point finally says so.

CPI is a joke, but is a favorite tool to use to argue there is no inflation. It justifies Ben keeping rates low. Now deflationists are using Bond prices to justify deflation. But this is human nature. We hold to our guns and justify our decisions with any old data possible. OJ was innocent. The gulf wars were about weapons of mass destruction. Whatever! Are we in the real world, am I wrong?

It seems like we are arguing about who would win in a fight? Spiderman or Batman. I vote for Batman by the way. :)

Banks are STILL marking bad loans mark to fantasy.This POS gold is going down hard. You fools that bought this crap will be sorry and the fools that are long and rode it to 1260 and back will be even more sorry. Deflation is here and Justin is right - "Credit contraction is DEFLATIONARY. Massive growth in credit is what sows the seeds for massive deflation. So we've sown the seeds, now we reap what we sow."

You inflationist are just plain wrong. There will be inflation only after the deflationary spiral that will take place. Get out of your gold now!!!!!

I think what you guys may not understand that the problem is that the post Bretton Woods economy requires continually increasing debt to not collapses. As you can see by the above refutation of Mish's deflationary view, credit contraction is by of itself not deflationary.

The problem is that the system grinds to a halt in terms of creating more debt in the private sector. So following Keynesian theory, the government keeps the debt machine rolling. It did this in Japan, but my argument is that it did not allow the money supply to increase (nor decrease) so you have benign price deflation to readjust the excesses of the 1980s. The US cannot mirror the Japanese model because of lack of savings, so it cannot be self-sufficient in issuing public debt. It actually depends on Japan and China to pick up the burden for mercantilist reasons.

In Japan they liberalized the agricultural segment a few years ago. I am sure that everyone knows the anecdote that an apple costs $10 in Japan. It's certainly not true anymore. So price deflation is a bad thing?

I think the end game for the US and Europe will be a lot worse than Japan and we should be lucky to emulate the lost decades even though it's not possible.

The US cannot mirror the Japanese model because of lack of savings, so it cannot be self-sufficient in issuing public debt.Frank, but the US is more than capable of attracting GLOBAL savings, so it is capable of mirroring Japan's model. It's just a different source of savings.I've said it before here, global savings for the US is analogous to Japan's domestinc savings.That's just the way the world works.The real problem, globally, is what happens when people decided to shun risk.I don't think we've even begun to see Americans shun equities yet and transfer wealth to government wealth at low yields.

The adjunct problem for the world is where to park savings.Sure, gold is an answer, which is why I'm heavily invested in Old Yeller, but when China cools, slows down, or plain crashes and this dreamy notion of Asian interdependence disappears from view, where will all the wealthy from countries that are not liberal democracies, where will they park their savings/wealth.Don't tell me they'll be stockpiling sugar or copper, oil etc....

But imagine the impact on things like US housing if bond rates creep just a small amount.Yes it would be horrible.Antal Fekete been reading him since 2002 or 3 I think over at safehaven. Been a while though, because he makes for some pretty rough reading...thanks

Yen upDollar upMarket downGold -- back down to 950-1000 to scare out the complacent longsBonds -- continue bull market until they don't

Look at NFLX and AAPL, two of the bigger market leaders since 2009. Both look very vulnerable now. Nice head and shoulders patterns on platinum and palladium now, probably doesn't bode well for gold and silver in the near term.

I posted this earlier. Inflation/deflation in things like housing and raw materials is real. You can't use economies of scale with those items. You also can't buy them cheaply from China.

Items that fill all those shipping containers from China like electronics/toys/clothing are cheaper because China sells them to us at low prices courtesy of non-existent labor laws and a lid kept on the Yuan. If all that plastic stuff was made in the good ole USA, prices would be much higher.

In real terms, PMs indicate inflation pretty well. They can't be produced cheaper in a foreign country and they reflect their worth in dollars. Look at the price of gold and other commodities since 2000.

From where I sit, watching the prices paid for raw materials and electronic components, I see inflation. A lot of this inflation hasn't made it to the consumer because the consumer is struggling. Eventually it will.Chinese goods will become more expensive and there isn't another "China" to go to for cheap, plastic stuff.

Q.: How will the current situation unfold? Do you think resolution willcome in the form of hyper-inflation, or will it come in the form of deflation?

A.: One has to be careful with these terms. Both inflation and deflation meandestruction of wealth through destroying the value of obligations; the formerthrough depreciation, the latter through default. It is also possible to have amixture of both simultaneously.If you insist on a straight answer from me, then chalk me up in thedeflation column. Signs of deflation are all around us. Torrents of freshly printedmoney are unable to turn receding prices and interest rates back. Confidence inpromises to pay is evaporating. Banks do not trust one another with overnightmoney. Paper gold is being pushed down the throat of those demanding physicalgold. Vanishing confidence has reached the stage of contagion. Paper wealth isdisintegrating before our very eyes. The domino-effect is spreading: the collapseof one firm brings down two other. Most frightening is the shrinking ofemployment. It threatens with leading to a break-down in law-and-order.Governments are completely unprepared for what is coming. They think that itis just a matter of printing more money for which they are so superbly equipped,and sprinkling it from a helicopter as if it were manna, to prevent furthercontraction. They

If you follow price action you don't have to worry about who says this or that, or whose theory is right or wrong. At the end of the day it doesn't matter whose theory is correct anyway (unless your goal is to win a debate or something) but rather if you're on the right side of the market or not. I'll switch coats and become an inflationist if I see a reason to do so on the charts, I have no problems with that. But people that choose sides like it's a sports team or a political party are setting themselves up for ruin if they're swinging all their money that way too.

If you think the dollar is going to fall beneath its all time low, you are crazy. That would require the euro going back to 1.60, and that is flat out not going to happen. The euro, yen, and pound (maybe the only three major currencies in the world in worse shape than the dollar) make up over eighty percent of the dollar index. What happens to those three currencies (especially the euro) will determine the future value of the dollar index as much as anything else.

Justin might not be in sympathy with the majority of the board, but he has laid out his case in a fair and reasonable manner. He even took the time to put a handle to his opinion, which is more than many bother with. Slagging him for having a different point of view is poor form.

I suggest you save your irritation for the dorks who like to trumpet their alleged winners and add nothing to the conversation.

I understand what you are saying, but doesn't Ben want to inflate us out of this problem. Isn't he really praying at night for inflation and a weak dollar for exports??? Deflation will be a steak through his heart. The money that is being printed is not advertised. There should be public works projects going on but that massive amount of printing that is going on is going to the States. They are bankrupt NOW. 46 of the states are under water today.

Wow it sounds like I've got some fans and some detractors. I've read a lot of stuff in the gold arena over the years and while I don't currently agree with Gary, he has written some good articles so props to that. If I'm wrong on my current call I'll gladly switch sides and get long a lot more gold and other stuff. If I'm right I'll just stay in my trade. I really don't care what side I'm on as long as it's the profitable side.

First off, I'm still holding a long term precious metals position. It's just reduced to the core since I'm not expecting gold to do much for a while. In fact I'm planning on buying more down the road.

The long dollar trade breaks down below 80 then 74. There's a chance it could form an even bigger base by holding 70 and then rebounding but I would have to see that happen first before getting back in.

Basically on gold I'm waiting for either a break of 1265, or a good fall, then consolidation into a base, from which I would buy in again once I see some strength.

There's very little I see technically promising in gold right now so mostly I'm just content to sit on the sidelines and see what happens. In fact that's pretty much the way it is for the overall market too. Even the leaders of the market are starting to show topping formations or break down, that's why I'm comfortable establishing short positions here too.

I'll close my shorts out if the market goes back above the April highs. That position I'm still building, if we get a break above 55 on SH then the inverse head and shoulders is probably in play.

I'm tired of PMs like silver not moving much for years. Yes, it went from crash low of 8 to 19, but so did most stocks. But for 5 years, SLV has barely moved higher. Sounds like a lost semi-decade to me!

PM's just aren't something you can be impatient with. They are volatile so when they decide to move they tend to move a long ways.

That is always followed by an extended consolidation. If however you can focus on the long term goal and just be patient you will be rewarded with huge returns.

If however you are unable to hold on you will just be sitting on the sidelines when the move happens. And of course when it comes it will immediately get overbought so if you are like most you won't be able to chase the move until it's almost finished.

Most people get bored and start trading trying to "make" something happen. They usually just end up whittling away at their portfolio. So in the long run they lost money because of their impatience.

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